/perspectives/weekly-viewpoint/monetary-morphine”-diluted-by-fiscal-foot-dragging

Monetary “Morphine” Diluted by Fiscal Foot Dragging

The Dow Jones Industrial Average (Dow) fell 0.15%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) dipped 0.24%, the Standard & Poor's 500® Index (S&P 500) lost 0.32% and the NASDAQ Composite Index (NASDAQ) shed 0.23%.

December 17, 2012    |    By Mike Schwager

Performance for Week Ending 12/14/12:

The Dow Jones Industrial Average (Dow) fell 0.15%, the Wilshire 5000 Total Market IndexSM (Wilshire 5000SM) dipped 0.24%, the Standard & Poor's 500® Index (S&P 500) lost 0.32% and the NASDAQ Composite Index (NASDAQ) shed 0.23%. Sector breadth was mixed as 7 S&P sector groups finished lower while 3 finished higher. The Materials sector (+1.64%) was the best performer, while the Consumer Discretionary sector (-1.23%) was the laggard.

Index* Closing Price 12/14/12 Percentage Change for Week Ending 12/14/12 Year-to-Date Percentage Change Through 12/14/12

Dow

13135.01

-0.15%

+7.51%

Wilshire 5000

14596.50

-0.24%

+12.33%

S&P 500

1413.58

-0.32%

+12.40%

NASDAQ

2971.33

-0.23%

+14.06%

*See Last Page for Index Definitions    
 
MARKET OBSERVATIONS: 12/10/12 - 12/14/12

The major market indices finished the week little changed as investors appeared reluctant to commit capital due to the lack of progress in the fiscal cliff negotiations.  News of more monetary easing and further signs the U.S. economic backdrop continues to improve, were essentially shrugged off as the pending fiscal cliff deadline loomed large. Investors also pushed to the backburner additional evidence that the Chinese economy has likely bottomed as well as the granting of additional bailout funding to Greece.

Despite the sideways slog, the markets continue to be incredibly resilient, suggesting investors still feel confident that some sort of resolution will evolve over the next few weeks.  While the window to strike a deal by year end is starting to narrow, investors also realize that reaching a deal would likely be well received by the market. In other words, investors may be gauging that the bigger risk is being out of the market versus in it.

While the inability to reach a resolution in the fiscal cliff negotiations over the next few weeks would likely result in a kneejerk sell-off in the markets, the weakness could also set the stage for a buying opportunity for longer-term investors. As mentioned in these missives numerous times, a resolution of the fiscal cliff is the most desired outcome (and still likely, in my opinion), however I also continue to believe that even a bad outcome may at least be partially offset by the removal of uncertainty. The one thing both businesses and investors despise it is not knowing the rules of the game. Therefore, if businesses and investors ultimately know where tax rates, etc. are going, they can better plan for the change and reposition their businesses/portfolios to operate more effectively within the new framework.

While near-term political risk will continue to dictate the near-term direction of trade, the overall macro environment remains very conducive for equity investors, in my opinion.  To wit, the housing market continues to gain traction, labor conditions are firming, auto sales recently jumped to their strongest pace in almost 5-years, gasoline prices continue to decline, the situation in Europe is (slowly) improving, the Chinese economy is showing signs of a bottom, valuation is very attractive, the S&P 500 has a higher yield (2.25%) than the 10-year Treasury (1.70%), investor sentiment continues to lean bearish (a contrarian indicator) and the Federal Reserve will maintain very accommodative monetary policy for the foreseeable future. While individually none of these factors will make the markets go higher, collectively they potentially set the stage for a powerful upturn in the market as we head into 2013 – stay tuned.

FOMC Meeting On Tap
Last week the FED reiterated their commitment to keeping their foot on the monetary gas pedal for the foreseeable future. At the conclusion of Wednesday’s FOMC meeting, the FED’s policy setting committee said the central bank will buy $45 billion a month of Treasury securities starting in January. The buying will be in addition to $40 billion a month of mortgage-debt purchases and will replace the Operation Twist program that is set to expire at the end of this year. The FOMC said asset buying will continue “if the outlook for the labor market does not improve substantially.”  In somewhat surprising move, the FED also said it will link its outlook for its main interest rate to unemployment and inflation thresholds.  The FED said interest rates will stay low “at least as long” as the unemployment rate remains above 6.5% and if inflation “between one and two years ahead” is projected to be no more than 2.5%.  

In “normal” times this additional shot of “monetary morphine” would have sent the stimulus junkies clamoring to buy stocks, however the looming fiscal uncertainty seemed to water down the FED’s action. Fiscal-related jitters were reignited following comments by FED Chairman Bernanke at the after meeting press conference. Bernanke once again reminded investors that FED policy ultimately doesn’t have enough juice to offset the negative economic drag associated with going over the fiscal cliff.

There also seemed to be an emerging fear that the FED’s aggressive action could lessen the urgency for policymakers to find some middle ground. In addition, with the introduction of inflation and unemployment thresholds, the question now becomes whether investors will view progress on the jobs front as a stepping stone towards the FED taking away the monetary punchbowl.  In other words, will we enter into a “bizzaro” world where improvements in the labor market are viewed negatively? 

The Week Ahead:
The economic calendar will be backend loaded this week with the bulk of the data coming on Thursday and Friday. Reports of interest this week include housing starts/building permits, the final revision to the third quarter GDP, the Philadelphia and Empire (NY) regional manufacturing reports, existing home sales and the University of Michigan consumer confidence data. In addition to the ongoing fiscal cliff saga, other events of interest include a handful of appearances by FED officials and an earnings update on Wednesday from economic bellwether FedEx.

MARKET VIEWPOINT

While uncertainty surrounding the resolution of the fiscal cliff will likely weigh on near term stock performance, expectations of an eventual solution should set the stage for higher asset prices as we approach the new year. Domestic growth has been gaining traction reflecting the resiliency of the consumer and the improving housing sector.  While the political “noise” will dominate the investment landscape in the near-term, equities remain attractive on a longer-term basis reflecting the combination of attractive valuation,  the overall healthy nature of corporate balance sheets and the commitment from the FED to maintain accommodative monetary policy through at least mid-2015.

Potential Risks/Wildcards: Expectations that equity prices will trend higher over time assumes that a resolution to the debt problems in Europe will be found, that monetary policy will remain accommodative, and that no major fiscal policy mistakes are made. An adverse outcome to any of the above factors would likely lead to a reevaluation of the bullish outlook.


Definitions

The Dow Jones Industrial Average is a price-weighted average of 30 blue-chip stocks that are generally defined as the leaders in their industry. It has been a widely followed indicator of the stock market since October 1, 1928.

Wilshire 5000 Total Market IndexSM represents the broadest index for the U.S. equity market, measuring the performance of all U.S. equity securities with readily available price data. The index is comprised of virtually every stock that: the firm's headquarters are based in the U.S.; the stock is actively traded on a U.S. exchange; the stock has widely available pricing information (this disqualifies bulletin board, or over-the-counter stocks). The index is market cap weighted, meaning that the firms with the highest market value account for a larger portion of the index.

Standard and Poor's 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The NASDAQ Composite Index is a broad-based capitalization-weighted index of stocks in all three NASDAQ tiers: Global Select, Global Market and Capital Market. The index was developed with a base level of 100 as of February 5, 1971.

The S&P/TSX Composite Index is a capitalization-weighted index designed to measure market activity of stocks listed on the Toronto Stock Exchange (TSX). The index was developed with a base level of 1000 as of 1975.

 

Indices do not include any expenses, fees, or sales charges, which would lower performance. Indices are unmanaged and should not be considered an investment. It is not possible to invest directly in an index.

The individual companies mentioned in this piece were for informational purposes only and should not be viewed as recommendations.

The comments should not be construed as a recommendation of individual holdings or market sectors, but as an illustration of broader themes. This document contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the individual strategist. Information in this report does not pertain to any investment product and is not a solicitation for any product. This material has been prepared using sources of information generally believed to be reliable. No representation can be made as to its accuracy.


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